Date: May 05 2012
In July last year, the chief economist at Westpac, Bill Evans, made front page news by becoming the first bank economist to predict the Reserve Bank would begin cutting interest rates by year's end.
Even as 18 out of 21 interest rate strategists surveyed by Bloomberg were tipping at least one more rate increase by the end of the year, Evans released a note arguing that interest rates were too high given the weakness in household spending and non-mining parts of the economy, and predicted rates would need to be cut by 1 percentage point.
As it turns out, Evans's prediction has come to pass; this week's half a percentage point cut in the Reserve Bank's cash rate adding to the two quarter of a percentage point cuts delivered late last year.
''Interest rates have been too high for too long and now I think they are registering that,'' Evans said this week.
As the federal government prepares to hand down its fifth budget next Tuesday, there exist two dominant and conflicting narratives about the Australian economy.
On one account, favoured by the government, economic growth is returning to average. Joblessness and inflation are low. The drought has broken. The biggest mining boom since the Victorian gold rush continues. The federal budget is returning to surplus under the careful stewardship of an award-winning Treasurer, supported by an independent Reserve Bank with plenty of ammunition in the tank.
On the other, favoured by the Opposition, economic growth is disappointingly weak. The mining boom and an eye-wateringly high Australian dollar have ripped a chasm between the mining and non-mining parts of the economy. The government, under an incompetent Treasurer, is recklessly cutting spending to meet an arbitrary political deadline for a surplus, flanked by a Reserve Bank which is behind the ball on interest rate cuts.
How to separate truth from reality?
Surveys suggest Australians are baffled, erring on the side of pessimism. Consumers' confidence about their personal finances is at levels not seen since the depths of the financial crisis, and before that, the early 1990s recession.
Business surveys too show parts of the economy struggling, while the stream of job loss announcements continues. Optus to shed 750 staff. National trucking firm 1st Fleet to close, wiping out 600 jobs.
Concerns about future job security and falling asset prices appear, for now, to be winning out over the good news that joblessness remains, on average, historically low.
Economists say the truth of the economy lies somewhere in between the best and worst case scenarios, with wide divergences masking the true picture.
''The economy is a bit like someone standing with one foot in a bucket of ice and one foot in boiling hot water: on average, everything's normal,'' says Merrill Lynch's Australian economist, Saul Eslake.
Crafting a national budget in such circumstances was always going to be difficult. Debate about next Tuesday's budget has focused largely on the government's commitment to returning to surplus in the coming financial year.
By returning the budget to surplus, the government says it will not only shore up confidence of international investors in the Australian economy, but open the way for the Reserve Bank to cut interest rates. Lower interest rates will, in turn, relieve pressure on the Australian dollar and non-mining parts of the economy.
But concern remains that economic growth is weaker than the government believes. In updated economic forecasts released yesterday , the Reserve Bank sliced its estimates for economic growth and inflation, suggesting further room to cut interest rates, as needed, to stimulate the economy.
Westpac's Evans is tipping the Reserve will cut by another half a percentage point by the end of this year.
''What we're seeing is that people are feeling nervous about their jobs. If you're feeling nervous about your job security, what you don't want to be made aware of is your high rate of debt'' - Australia's household debt-to-GDP ratio is the highest in the world. ''If the asset that's supporting that debt is performing, it's OK. But in the case of Australia, it's not. House prices are edging down.''
Evans points out that the economy did not create any jobs last year, but adds that things should improve as interest rates come down and house prices stabilise.
Other factors too, are weighing on consumers. According to Eslake: ''They think the carbon tax is going to have a bigger impact on them than it actually will. They're annoyed that banks haven't passed on reductions in interest rates in full. They hate the government - that's nothing political, it's just what the opinion polls are saying.
''I don't think the government is incompetent, but the public certainly has been persuaded by the efforts of the Opposition that they're the most incompetent government since Whitlam.''
Meanwhile, job losses in non-mining sectors of the economy like tourism, manufacturing, education services and retail are mounting. ''They're all bigger sectors of the economy than mining,'' observes Eslake.
''They employ a lot more people and tend to be located where large proportions of the population live, and it's probably no longer true to say that the gains in those parts of the economy that are doing well are offsetting the losses in parts of the economy that aren't.''
Eslake says the government's assumption that economic growth will return to trend - about 3 to 3.25 per cent - is overly optimistic. He is tipping economic growth of just 2.75 per cent in the year ahead and a rise in the jobless rate to 6 per cent. If more people hadn't abandoned the search for work in the past year, the jobless rate would already be close to 6 per cent, he says.
From a bigger picture point of view, Evans warns Australia's unique period as a ''miracle economy'' has come to an end. ''What was the main reason why we had this 'economic miracle'? Households geared up, they borrowed and they put it into houses. House prices were going up and people drew down on that wealth to spend.''
''That's what kept us going for 15 years, it wasn't any miracle, and that's come to an end. So we need something else - presumably something like the mining boom, but that's centred around such a narrow base, it doesn't represent the answer. ''We have got to get some stability. But we'll never quite go back to the way things were. The global debt boom is well and truly behind us. And it's not just us, it is the world.''
Not all economists are quite so downbeat. The chief economist at HSBC, Paul Bloxham, believes consumers are not quite as unhappy as they say they are. Households, when asked about their confidence levels, are simply responding to a period of acute and rapid structural change in the economy brought on by the higher Australian dollar.
''It doesn't seem consistent that people are so unhappy about the state of their finances but international departures are at record levels,'' he says. ''I think the economy's structure is changing quite quickly and structural change is hard. Some people win and some people lose.
''The mining boom is beneficial over all, but not everyone wins and the benefits are more unevenly distributed. It's only a small segment of the population that really gets to feel the direct benefits.''
However, all households were benefiting from the boom, because the higher Australian dollar, while hurting some industries, had increased the purchasing power of all Australians over foreign goods and services, from online purchases to holidays abroad.
''The problem is we'd adjusted to a world where the benefits were coming through from rising asset prices, like house prices. The benefits are now coming in a different form, including the low jobless rate. It's coming through income growth, rather than asset price growth, and through greater purchasing power. That's conceptually harder to understand and it's less visible.''
Bloxham points to a strong pipeline of mining investments and a pick-up in jobs growth this year. The economy created 26,000 jobs each month during the first three months of the year. While job losses attract headlines, job gains are less visible. The two strongest sectors for jobs last year were health care services and mining.
''The services sector we know has been holding up pretty well and that's the bulk of the Australian jobs market. We spend a lot of time talking about retail and manufacturing and mining, but the biggest employer of Australians is the service sector.''
This is the economic context in which next Tuesday's federal budget will be delivered. Having been pilloried by economists and commentators in previous years for failing to deliver sufficient spending cuts, the Treasurer, Wayne Swan, now finds himself facing criticisms that planned budget cuts - the biggest since treasurer Peter Costello's first budget - will go too far.
The government has confirmed cuts in the order of $5 billion a year will be required to keep its surplus, thanks to a slump in revenues from company profits and capital gains.
Despite the mining boom, Treasury Secretary Martin Parkinson has warned of ''wafer thin'' budget surpluses in the coming decade thanks to slower capital gains, lower company tax collections from currency-affected industries and the use by mining companies of accelerated depreciation offsets.
Veteran budget watcher and Access Economics director, Chris Richardson, says cuts of between $5 and $6 billion a year will have little impact on the overall macro economy, particularly when many of the cuts can be made by simply time-shifting spending, either by pulling it forward, or pushing it back.
With the euro crisis on the backburner, for now, Richardson says there is less danger that budget cuts will hurt the economy, and, indeed, returning it to balance is, in the medium term at least, an important goal.
''Although I probably wouldn't rush to surplus in the next little while, there is a bit of me that's thinking there are some good decisions being made.''
The government announced on Thursday it will save roughly $5 billion by cutting defence spending, in particular by delaying the purchase of F34 strikefighter jets.
Eslake praises the move wholeheartedly: ''I think there's far too much money wasted on expensive toys. They should do the same thing with submarines.''
Eslake also expects the government's surplus, if achieved through reprofiling of spending, will not do too much harm. ''Part of me wants to say that's all accounting chicanery. But at the end of the day, while that matters slightly, it actually doesn't do any harm.''
An economist and former adviser to various Labour governments, Barry Hughes, says the government is right to trumpet its achievement during the financial crisis, but its story of Australia as a ''world beater'' economy is wearing thin.
''They do have a very good story to sell and that goes back to 2008 and 2009. If you look at the evidence, it wasn't the resources states that stopped unemployment going up.'' It was the fiscal stimulus. ''People have had a lot of fun at their expense by pointing to the waste, but I remind you that no less a figure than Adam Smith once said there is an awful lot of ruin in the economy.''
''I think that's what got them the [EuroMoney magazine] gong [for world's best treasurer] and I think that's deserved. But I'm rather concerned about the way the future is developing.''
Hughes says it is no longer true to say Australia is a ''world beater'' among the developed or developing world, as growth in some parts of Europe and the United States returns.
''We've got a good solid reasonable performance but I don't regard us as light years ahead.''
Like most economists, Hughes dismisses the debate about the 2012-13 surplus as ''a great fuss about nothing''.
''The important thing is when they get into surplus, and when you do start to see growth return, that they don't rest on their laurels.''
The biggest question hanging over this budget is, according to Hughes, how long the present terms of trade boom will last and whether it will, in the long run, hollow out the manufacturing parts of the economy.
''The higher Australian dollar has, in a way, fast-forwarded the future for us. Trends that were occurring over a longer period have been fast-forwarded by about a decade.
''Everyone says our future is in advance manufacturing, in high-value-added goods and services. But what does that mean? Policy should be asking: what are we good at? What are we going to do when the terms of trade fall?''
Whether or not the budget is in surplus or deficit next week pales in comparison to these longer-term questions, says Hughes. ''We have bigger fish to fry.''
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